Since 2008, an independent look at challenges and opportunities in sports and financial investing, with occasional diversions as my mood takes me. Nothing is for sale, and this not a Profit and Loss report either. They're boring.

Tuesday, 4 June 2013

From the Finance pages of The Daily Telegraph comes this interesting article by Alistair Osborne on the failure of CVC’s takeover bid for Betfair. It’s a well written article on what could be a dry topic, but there are a couple of subjects that are especially interesting.

One is the mention of the Pareto Principle, something discussed on this blog back in January 2011 and well worth reminding ourselves of. Most of us are probably guilty of spending a lot of unproductive time on the exchanges, but if we are making £100 or so net for a day’s ‘work’, it’s easy to overlook the fact that perhaps at least 80% of that time generated very little in terms of profit.

To a large extent, you never know when a value opportunity will come up, but if you keep records, it's not too difficult to see where your time is likely to be most valuable, and where you are spending hours making very little. With the Premium Charge now in effect, it’s more important than ever to be aware of this, as the same ‘working’ day now brings in just £50.

Slightly off-topic, but several years ago, I had an agent who negotiated a contract renewal for me, and was delighted to inform me that the deal was for my weekly pay to increase by £50 a week. I was all set to sign on the dotted line, when she added that there had been a small change in the hours I was expected to work, which on further inspection turned out to be the not so insignificant increase in my working hours from 35 to 37.5, or 7%. A quick calculation showed that my hourly rate would now actually be less than that of my current contract, but it took some time for her to understand how I could consider an ‘extra’ £50 a week to be decrease in pay. “But you’re getting £50 more!” she kept repeating.Speaking of wasting your time, I checked in on Odwyer’s blog the other day, and saw that he had made £679.28 in three months since his last post. As the single comment pointed out though:

675 pounds for three months work?? Is it really worth the effort. I could understand the pnl if it was pocket money part time betting but you assume you'll make a living at this.

As pocket money, anything extra is good, but one would hope John is not full-time - at least full-time with the option of a 'proper' job. If you're trading to occupy yourself while collecting unemployment, then I suppose it falls into the pocket money category.

The other paragraph that stood out was this one:

So he [Richard Koch] advocated cutting customer numbers to focus on the big fish, not the minnows. That would have allowed a drastic cut to the annual marketing budget – from £90m-£100m to just £20m – as Betfair stopped trying to lure tiddlers interested only in £10 free bets. “You have to focus on the core customers and provide new products for them,” he says.

While it has long been clear that the cost to Betfair of acquiring new customers is high, the flaw in the ‘focus on the big fish’ theory is that big fish need tiddlers to feed on.I would imagine a pool containing a small number of big fish would likely be a fairly quiet one with only sporadic bursts of activity. Unlike the minnows who are somewhat naïve about where to hang out, and as a consequence don’t last too long, the big fish are a little more savvy, and wait patiently until a clear advantage is seen. The frenetic activity seen in the pool a few years ago is seen no more. One of the justifications for the implementation of the Premium Charge was that tiddlers were disappearing too quickly, and the big fish were to be discouraged. Unfortunately the plan doesn’t appear to have worked – the big fish swallowed the 20% commission rate, while still enjoying a healthy diet of tiddlers, but new tiddlers were now less inclined to enter the pool.The Premium Charges, while unlikely to affect most newcomers, was nevertheless confusing and a disincentive to making the effort to learn a new platform. Many low tax-rate payers object to higher taxes because they believe that one day they will be in that group themselves. The Betfair Dream.Most tiddlers at least like to dream of making it big, however unrealistic that dream might be, but the moving of the goalposts made many realise that the dream was now a lot harder. The presence of a Betfair Education / Training department (the collective noun for fish is ‘school’ for a reason) at least gave the impression that the sports investing world was your oyster, but the “Sharp Minds” that Betfair claimed to be catering for are, turned out to be not so good for business.The Premium Charge though, didn’t thin the big fish out enough, so more drastic steps were taken. In an attempt to starve the biggies, up to 60% of their catch was now removed from their mouths before they could swallow, and it’s debatable how much of that stolen catch was then returned to the pool.Meanwhile, the dream for newbie tiddlers was now even more unattainable. Who would enter the pool knowing that in the best case scenario, they had maybe 10 years earning an average income (without the National Insurance credits needed for a full state pension) before running afoul of the Super Premium Charge, and aware that the £250,000 ‘limit’ could easily become £25,000 or £2,500 at the drop of an email? Winners are always welcome" was no longer true.

Betfair's former promise that "winners are always welcome", quietly withdrawn when the first 20% premium charge was introduced in 2008, clearly no longer seems to apply to this group [winners] and that's a shame (although Betfair would no doubt argue that winners remain more welcome with them than with fixed-odds rivals – they just have to pay more than they did before).

The rake might be good, but new customers are intimidated by the success of a few. Unfortunately for Betfair, increasing the rake does nothing to reduce the potential customer’s reluctance to join in, and in fact only exacerbates it by indicating that even were he to do well, he would then be heavily taxed.

The ones you have to feel sorry for are those mid-size fish who gave up jobs or even careers and made a positive decision to go full-time on Betfair and who never saw these changes coming. How many pros are now second guessing themselves and wondering where sticking to a more conventional career path might have taken them?Meanwhile the big fish evolve. Some evolve legs and leave the pool, perhaps trying their luck at the Purple Pool and return for a nostalgic drink every now and then, while others splash around treading water, looking somewhat lost and making do with a few scraps. Some may have always had other food sources, so it’s not life or death to them - even half of a few tiddlers is better than nothing as a little extra – but for those who have no food other than measly benefits, it must be disheartening.Big fish became big fish for the most part by feeding on tiddlers, and now have no desire to be swallowed up by an even bigger big fish.Perhaps some even evolved wings, and took off for new pastures altogether, leaving behind the cutthroat world of sports investing?Quite refreshing also to read that Koch believes “You just have to think carefully about what you do. The secret is to be lazy but also extremely ambitious. I don’t work very hard, probably about three hours a day.”Work smart, not hard, in other words. Here is the article in full:

Richard Koch is not used to failure. The author, investor and 6.4pc Betfair shareholder puts his personal wealth at £140m, says his financial priority is “to become a billionaire” and has just published a book sub-titled “Ten Ways to Become a Great Leader”.

So ask him why his bid for Betfair fell over and he looks genuinely perplexed. Mr Koch, 62, had teamed up with private equity firm CVC to table a near-£1bn offer for the betting exchange group and came within a nose of landing the prize.

“We really should have got the company,” he says, giving his first interview since the collapse of the bid last month. “We had a lot of shareholder support – over 50pc. I still don’t really know why it failed.” He bursts out laughing, tending to back his claim that “there’s no point being cross” about the outcome.

“No doubt we made some tactical mistakes. But the main reason was probably time,” he says.

“Everything had to be done in a rush because of the requirements of the Takeover Code. We got the worst possible introduction to the chief executive, Breon Corcoran. I’m a great fan of his. But he didn’t really like some of the pressure he was being put under, I don’t think. And we weren’t able to talk to him until the very last minute.”

In a manic 48 hours, CVC twice raised its indicative bid from 880p a share to 920p and then 950p. And that was before it dangled the prospect of around 975p if the board let the private equity raiders talk to Mr Corcoran, who joined Betfair last August from rival Paddy Power.

“He was put in a very difficult position where he had to basically decide whether he was going to go along with it. And because we were such fans of his we didn’t have an alternative management team, which was probably a mistake,” says Mr Koch sheepishly. “If we had our time again we would do it slightly differently.”

Mr Corcoran’s position was made all the harder because he had outlined his own strategy for Betfair just days before meeting CVC. Upping the ante, he raised guidance for full-year profits, increased cost savings from £20m to £30m and provided early evidence of how adding the new sportsbook to the traditional exchange was boosting customers – though he stopped short of returning any of the company’s £150m free cash.

Mr Koch, a huge fan of the exchange model of peer-to-peer betting, had an altogether different plan for a business he had bought into in 2001, roughly a year after its launch. His £1.5m wager has already proved his “most successful investment” – better even than Filofax and Plymouth Gin. He sold 23pc of his holding to Japan’s Softbank in 2006, making a £27m pre-tax profit.

His plan for Betfair had echoes of the “Pareto Rule” that has come to shape his life since, as a 19-year-old student, he stumbled across the work of 19th-century Italian economist Vilfredo Pareto in Oxford’s Bodleian library. The rule broadly stipulates that 80pc of results come from a relatively small amount of causes – just 20pc. He has seen this everywhere, citing a historic survey from the Prudential insurer that showed “80pc of the sales were sold by 20pc of their salesmen”. Fifteen years ago, he wrote a book, The 80/20 Principle, which has sold more than 1m copies.

The principle, he insists, goes just as well for Betfair’s 900,000 customers. “One thing that relates to the book is that it is usually a small amount of customers that accounts for a large proportion of your profitability,” he says.

So he advocated cutting customer numbers to focus on the big fish, not the minnows. That would have allowed a drastic cut to the annual marketing budget – from £90m-£100m to just £20m – as Betfair stopped trying to lure tiddlers interested only in £10 free bets. “You have to focus on the core customers and provide new products for them,” he says.

There was another major difference, however, for a business still reeling from 2010’s £13-a-share float. “The basic thesis, apart from the change of plan, was that this should not have been a public company,” he says. “Let’s face it, it hasn’t been successful and it has a balance sheet that has got about £150m cash. It generates a lot of cash, so it’s a perfect proposition for a moderately leveraged bid.” The Koch/CVC plan envisaged “about £350m” of debt – and it’s easy to see why investors, including Softbank and co-founders Ed Wray and Andrew Black, were prepared to back it.

“Shareholders could keep their existing stake and pretty much get back what the share price was before the bid,” says Mr Koch. “They could have their money and still have the same percentage stake in the company, which is the magic of gearing. You can’t do the same thing in a public company.”

So how did his bid lose? The board had few cards, he says, but “the major card was Breon. We also had to get a recommendation from the board. Gerald Corbett, the chairman, played it extremely astutely. He had a weak hand but he managed to get a pretty high price and at the end I think he was pretty surprised it didn’t happen either.”

He says he understands Mr Corcoran’s position too. “Think about the psychology of it. He had been a loyal chief executive, trying to defend the company and make sure if it was sold it was sold at the best possible price. It was a friendly bid. But in the heat of battle people take up positions. So the psychology of it was all wrong. It had got to the end and then he gets told, 'perhaps we should accept the bid and do you want to go along with it?’. He was forced to make a decision in a very short period of time. And this is pure speculation on my part, but it sounded as if he just felt it was unreasonable.”

He believes the talks could have been extended, but is not one to dwell. “We had a chance.

We made some mistakes. And we came extremely close. But that’s life,” he says. “I am now a loyal shareholder. I have been put back in my box and I’m quite happy in my box.” He’s since had “a long friendly telephone call with Breon. I like the guy. He’s very humorous.” Both believe in new products making the best of the exchange and the sportsbook. So now it’s back to writing books. His latest is a familiar theme – The 80/20 Manager – which applies Pareto’s law to management. “I started thinking can you measure a chief executive’s productivity,” he says. “Their basic job is to make decisions. Only a tiny proportion of their time accounts for the good and bad that they do.”

He cites Michael Eisner, the former Walt Disney boss. “He was time-panicked because he was obsessed with working hard. He once said in 28 years he had only taken one day off. One day he gave a eulogy for Frank Wells, one of his key managers, and he said 'sleep was Frank’s enemy, he always wanted to get one more meeting in’. Well this was a eulogy given at the guy’s funeral. He died in a helicopter crash because he was rushing from one meeting to another. If it wasn’t so tragic it would be really funny.”

He says Eisner was “very successful in the early days at Disney. But they did a study and found that about 95pc of the profit improvement came from three decisions: he put the price up at the theme parks, he opened more Disney hotels and he put the animated classics, like Snow White and Bambi, on DVD. How long did it take him to make those decisions? Maybe a week.” So what did he do for the rest of the time. “Beats me,” he says. “I really think there is a myth about management. Everyone believes in hard work, but actually it’s about making the right decisions.”

Mr Koch dismisses the notion that it’s only by making thousands of decisions that you make the right three. “You just have to think carefully about what you do. The secret is to be lazy but also extremely ambitious. I don’t work very hard, probably about three hours a day.”

It’s a work ethic that has produced houses in the Algarve, Marbella and Cape Town, and time for “riding my bicycle through the orange groves” and “long walks with my partner and my dog”.

“I always say to people the most important decision you can make is which company to work for and which particular boss to work for. Unless the company is growing very fast and unless the boss is going places, you won’t.”

It was a philosophy that saw him leave Boston Consulting after being “effectively fired” and join a consultancy growing five times as fast – Bain – before leaving to start LEK, another management consultancy. “If a company’s growing at 40pc to 50pc a year, you can hardly go wrong.”

He grins. “If you seriously want to be rich, I don’t think it’s very hard, you just have to be crafty at spotting opportunities.” His current portfolio includes fantasy sports group Fan Duel, payments company Ixaris and hair-removal outfit CyDen. Who knows, one of them may even turn out to be the next Betfair.

Betfair's problem is the same for both. The betting sites that have stolen a march on Betfair since 2008 are the big online bookies not other exchanges. The idea that PC "killing the dream" explains Betfair's relative decline is hilarious - the punters have all gone to bookies where that dream never existed.

If there's a punter out there who loses £200 over the lifetime of his account then Betfair spending £90 to acquire him loses them money (if PC payers take "only" £120 and Betfair "greedily" takes £80). Bet365 could spend double that, £180, to get hold of the same customer and still be quids in (because they won't share his losses with anyone).

Exchange betting had its glory days 2002-2006, when in-play took off and the bookies' in-play offering was rubbish or non-existent. Unless you've got a plan for making the bookies' offering worse for losing customers then the game is up.

The exchange is just a bookie with pricing/trading outsourced to a couple of thousand people for £500,000,000 a year (and who think *they* pay Betfair). Put it like that and the problem is pretty obvious. It won't stop the self-interested from claiming that the only thing Betfair needs to do to get back on track is scrap the PC, e.g. outsource pricing/trading to the same people for £550,000,000 a year instead!

About Me

I have had a life-long interest in sports and after studying Pure Mathematics with Statistics at secondary school, have been fascinated by odds and probability.
The first system I came up with was a simple one - back the favourite and double up after a loss until a winner. Simple enough in theory, and I told my Dad about it. Not being a betting man himself, he ran it by some of his colleagues, and came home to tell me that it wouldn’t work because a long losing run would mean that the bank would be empty. Then there was always the possibility that the winner would be returned at odds-on, meaning that the total returns would not match the outlay. Not what a ten year old wants to hear! Only slightly daunted, I then went on a search for the Holy Grail, the secret to riches that I knew was out there somewhere. Finally in 2004 I stumbled across an article about Betting Exchanges and four years on I am able to make a steady profit. I am at that age where I can start thinking about retirement and anything I make from trading sports will bring that day forward.